Supreme Court Declares Software Payments as Business Income, Not Royalties

The Supreme Court of Pakistan’s review bench has determined that payments for the use of computer software are to be treated as “business income” rather than “royalty.”

The bench, comprising Justice Syed Mansoor Ali Shah, Justice Athar Minallah, and Justice Aqeel Ahmed Abbasi, delivered its judgment in Civil Review Petitions No. 988 to 1001 of 2023 (M/s Inter Quest Informatics Services vs. Commissioner of Income Tax, etc.).

The petitioner, a Netherlands-based company that is not a resident of Pakistan for income tax purposes, had agreements with Schlumberger Seaco, Inc., which operates in Pakistan. The company claimed exemption under Article 7 of the Convention Between Netherlands and Pakistan for the Avoidance of Double Taxation and classified receipts under these agreements as “business profits.”

However, the tax authorities classified the proceeds as “royals” under Article 12 of the Convention and levied a 15% income tax. The taxpayer is granted a favorable judgment by the Supreme Court, which invalidates the tax department’s classification.

The Income Tax Officer, Commissioner of Income Tax (Appeals), and the Tribunal determined that the petitioner’s payments were classified as “royals” in Pakistan and, as a result, subject to income tax.

References were used to challenge assessments, appeals, and Tribunal judgments in the High Court. The petitioner won when the High Court found that the payments earned for leasing FLIC cassettes (software programs) under the Agreements were not “royalties” under the Convention and were not subject to Pakistani income tax.

The respondent tax department appealed to the SC, and the majority judgment under review overturned the High Court’s judgments and reinstated the Tribunal’s and Income Tax Officers’ original and appellate rulings. The minority judgment rejected the respondent’s appeals and affirmed the High Court’s decisions.

In a unanimous review judgment on November 28, 2024, the Supreme Court of Pakistan reversed its previous decision, saying that payments for the usage of computer software are commercial revenue rather than royalty.

The court stated that payments for the right to use or operate software do not qualify as royalties or technical service fees under the law. This ruling clarifies major uncertainties in the prior judgment, which has now been recalled.